This article appeared originally in Gulf News: link to original article
Government spending or consumer spending? Should one prevail over the other in terms of driving growth in an economy?
This article will compare and contrast the two with a few examples provided, with somewhat more focus on China. An advocate of Keynesian economics would propagate the notion of a government taking fiscal and monetary actions to spur growth in an economy in times of recession or depression.
The idea is that governments can lower taxes (fiscal) to encourage capital investments, for instance. Or government can lower interest rates (monetary), to encourage debt-fuelled growth either via corporates again, capital investments, or through consumers’ spending. I will get into this later on.
In a nutshell, government actions taken should be garnered towards creating or stimulating demand in a slowing down economy and hence, hopefully, the desired inflation. And if the idea is further developed to fit into today’s status quo, Japan’s push to have minimum wage increased by corporates is one new government action, and deferring a new sales tax increase to 2019 after the latest one is another.
And the same could be said of China cutting its reserve ratio for banks, to increase liquidity in its markets. So, how healthy is government spending?
In developed economies, the only way forward is perhaps what has been mentioned above, in an attempt to encourage consumers to spend in the economy. There is today almost no room for further infrastructure build-up, unless government spending is directed towards the upgrade and maintenance of existing infrastructure.
Despite that, this would probably be subject to where infrastructure-related jobs fit into the economy’s specific pay scale and the standard of living. However, and with the overall trend towards A.I. (artificial intelligence) and automation, spending efforts on infrastructure build up and maintenance could be greatly undermined.
Consumer spending could be normally existent in an economy, with limitations related to any increase in spending on imports, as well as those associated with limited income or low GDP per capita in purchasing power parity terms.
And so the actions described earlier could act as catalysts to spur further spending, with an interest in keeping that spending away from becoming a debt-fuelled one as much as possible, which is China’s problem today. Through different channels, China is providing liquidity to local governments as well as corporations.
This led to an inflated debt-to-GDP ratio of above 300 per cent. Even though household debt-to-GDP ratio remains modest in comparison to corporate, the corporate one could have long-term implications on consumer spending if they eventually were allowed to default and go bankrupt. China here is a case in point.
In comparison, consumer spending is more desirable if planned carefully and balanced with government spending. And as long as it’s not debt-fuelled, higher consumer spending could be tolerated and should be desired for future growth prospects.
In my opinion, government spending should be evaluated and implemented after answering two questions: One, Would that spending help create jobs? If yes, could they be sustainable without further government spending?
If the final answer is no, government spending would only create temporary growth spurts, but nothing sustainable.
And two, can government spending lead to increased domestic demand without jeopardising long-term financial stability in its accounts? As a government decides to cut taxes, it could put itself in a dire situation of reduced revenues and not necessarily reduced expenses.
This could create a constant strain on its accounts if constantly done, and repeated. However, if the answer to the question is yes, the government would then have to decide on the scale of its intervention to stimulate aggregate domestic demand.
In all cases, and to ensure sustainable growth, any government must focus on a sustainable solution, with an acknowledgement of possible down cycles during which governments’ actions are more desirable to boost domestic demand.
The last thought that I want to leave you with: what will happen to growth in China if its consumer spending reaches US levels?